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3 Steps To Profitable Stock Picking
Stock picking is a very complicated process and investors have
different approaches. However, it is wise to follow general steps to minimize
the risk of the investments. This article will outline these basic steps for
picking high performance stocks.
Step 1. Decide on the time frame and the general strategy of the investment.
This step is very important because it will dictate the type of stocks you buy.
Suppose you decide to be a long term investor, you would want to find stocks
that have sustainable competitive advantages along with stable growth. The key
for finding these stocks is by looking at the historical performance of each
stock over the past decades and do a simple business S.W.O.T.
(Strength-weakness-opportunity-threat) analysis on the company.
If you decide to be a short term investor, you would like to adhere to one of
the following strategies:
a. Momentum Trading. This strategy is to look for stocks that increase in both
price and volume over the recent past. Most technical analyses support this
trading strategy. My advice on this strategy is to look for stocks that have
demonstrated stable and smooth rises in their prices. The idea is that when the
stocks are not volatile, you can simply ride the up-trend until the trend
breaks.
b. Contrarian Strategy. This strategy is to look for over-reactions in the
stock market. Researches show that stock market is not always efficient, which
means prices do not always accurately represent the values of the stocks. When
a company announces a bad news, people panic and price often drops below the
stock’s fair value. To decide whether a stock over-reacted to a news, you
should look at the possibility of recovery from the impact of the bad news
. For example, if the
stock drops 20% after the company loses a legal case that has no permanent
damage to the business’s brand and product, you can be confident that the
market over-reacted. My advice on this strategy is to find a list of stocks
that have recent drops in prices, analyze the potential for a reversal (through
candlestick analysis). If the stocks demonstrate candlestick reversal patterns,
I will go through the recent news to analyze the causes of the recent price
drops to determine the existence of over-sold opportunities.
Step 2. Conduct researches that give you a selection of stocks that is
consistent to your investment time frame and strategy. There are numerous stock
screeners on the web that can help you find stocks according to your needs.
Step 3. Once you have a list of stocks to buy, you would need to diversify them
in a way that gives the greatest reward/risk ratio. One way to do this is
conduct a Markowitz analysis for your portfolio. The analysis will give you the
proportions of money you should allocate to each stock. This step is crucial
because diversification is one of the free-lunches in the investment world.
These three steps should get you started in your quest to consistently make
money in the stock market. They will deepen your knowledge about the financial
markets, and would provide a sense of confidence that helps you to make better
trading decisions.
